Deal Valuation: Inclusion of Costs to Achieve_Part 3

This post concludes our valuation section with a discussion of business cases.  Business cases are by far the more common approach to CTA calculation, as most clients do not have an acquisition pipeline robust enough to warrant the creation of standard TOMs (see June 2018 post).  Not surprisingly, the method for developing business cases is determined by the deal rationale, since the underlying objective is to model the cost to achieve the key deal value drivers.

Cost Synergy, Business Cases
If the primary value drivers of your deal result from cost synergies, you might consider a twofold approach.  Most cost synergy deals realize much of their value through personnel reductions.  If this is applicable ask yourself which of the following applies:

1. Personnel reductions can be executed without significant integration activity or
2. Substantial integration is required as part of the personnel reduction (i.e. you must first relocate operations to a new facility, train staff, etc.)

If item 1 applies to your deal, then you may be able to forgo the business case process altogether, or you may be able to streamline the scope of the business cases, and still obtain an accurate estimate of costs to achieve.  This is because personnel reduction, absent of dependent integration requirements, can often be easily estimated without the need for business cases.  Just ensure that Human Resources is involved, and that the following items are included to the extent applicable:

• Severance package costs
• Golden parachute costs
• Travel, i.e. for HR consultation
• Communications costs for FAQ’s, portals, hotlines, etc.
• Incentive packages for acquired resources you wish to retain (usually needed to maintain morale)
• Compliance costs for filings, notifications, labor counsels
• Legal fees, particularly if collective bargaining agreements or other contractual agreements apply

If item 2 more accurately describes your situation, I recommend creating business cases to support CTA for at least 80% of the total cost synergies included in the deal valuation model. 
Besides personnel reduction, the most common areas for cost synergies are:

1. Facilities consolidation
2. Operational consolidation
3. Input cost reduction due to increased scale
4. Back office cost reduction, including professional fees and compliance costs

Of these the first 3 generally contribute the greatest operating (non-personnel) cost synergies and the first 2 also generally have the highest costs to achieve; however, if input cost reduction requires renegotiation of purchasing agreements, this can be time-consuming and costly as well.  Whether you decide to do business cases only for the first two, the first three, or all the above is a matter of judgement.  Remember, the goal is to get accurate CTA estimates supporting at least 80% of your projected cost savings to substantiate the deal valuation.
Note that if your situation does call for business cases, you will need to provide a framework for analyzing the benefits of personnel reduction.  If you are going to account for these benefits with a simple analysis- as described earlier in this chapter- ensure that all operational business cases omit such benefits to avoid double-counting.  Alternatively, you can have each functional team coordinate with Human Resources to accurately estimate the personnel reduction benefits and one-time costs to achieve, including these in the functional models.  Either approach will work.

Section	Contents
​Cover page	Business case name Business case owner or lead Key assumptions Key dependencies Review & Signoff, names & dates
Financial Summary	Date of savings commencement Annual amount saved thereafter Near term one-time costs to achieve New recurring costs (timeline matches onset of savings) Net present value of initiative
Detail on CTA	Breakdown of key costs, including estimating assumptions, timing, and amounts
​Detail on Recurring Operations	EBITDA without the initiative Annual cost savings with initiative Additional new recurring costs EBITDA with the initiative
​Sensitivity Analysis (Optional)	If desired, a sensitivity analysis presenting conservative, moderate, and aggressive scenarios

 
Using this layout, a cost synergy initiative business case will usually run from 4 to 10 pages, depending on the level of detail provided.  Note that not all initiatives will have new recurring costs, but if a new process or operating model, i.e. outsourcing, is being deployed this will apply and should be included. 
Once the business cases are drafted, review them for the following:
​

• Consistency and validity of the stated assumptions.  Key assumptions, such as change-of-control date, should be provided and used consistently across all CTA business cases.  Other assumptions, such as interim staffing fees, should be substantiated with quotes or invoices from recent programs. 
• Alignment with communicated TOM.  If the target operating model calls for outsourcing, the business case should reflect this. 
• Consistency of EBITDA figures with the projections in the deal model.
• Congruent timing, particularly where there are dependencies.  This is especially important if using external resources with duration-based (i.e. hourly) costs.
• Duplication of any personnel reduction benefits or costs, if separate personnel reduction business cases or analysis were prepared, or if the same redundant personnel might be inadvertently included in more than one business case.

I find it is useful to bring the various teams together to discuss their drafts and findings at least once prior to submission of the final cases for review.  This simple step often eliminates a great deal of overlap and confusion, while providing the teams with insights and encouraging collaboration.  It is perfectly acceptable to begin stress-testing certain assumptions during this interim readout.  For example, can teams share resources?  Or can resources be procured more affordably if sourced under a shared contract?  Can additional savings be realized by breaking dependent tasks down into smaller increments, allowing dependent teams to start more quickly?  These early conversations begin to flesh out the TOM realization process and will benefit the team as the planning process develops.

Revenue Synergy Business Cases
For stand-alone or minimal integration transactions with revenue synergy value drivers, costs to achieve should be minimal.  After all, the presumption is that you are leaving the target largely as-is, and any revenue benefits are coming from accretion and perhaps organic revenue growth, not from combined operations. These deals will likely not require CTA business cases.

For deals with extra-accretive revenue value drivers, the business cases are more complex. You will need to carefully rationalize your selected TOM to determine the integration initiatives required to achieve the level of joint operations necessary to realize your synergy projections.  One useful approach to this is to create a forward-looking joint product roadmap; however, note that detailed competitive information is still likely under gun-jumping restrictions, so you will need to rely on carefully documented assumptions in creating a roadmap that supports your conclusions.
​
Once the roadmap is prepared, you can then conduct an addressable market analysis, and evaluate your projected share capture.  Combined with your pricing assumptions- and a price elasticity analysis-, this approach should substantiate the viability of the revenue synergies in your deal model.  At this point you can proceed with the CTA business cases using nearly the same approach as described above for cost synergy value drivers, with a few key differences.  The template for an extra-accretive revenue cost-to-achieve business case should include the following:

Section	Content
​Cover page	Business case name Business case owner or lead Key assumptions Key dependencies Review & Signoff, names & dates
Financial Summary	EBITDA without the initiative (includes accretive revenue and legacy cost structures) EBITDA with the initiative (accretive and extra-accretive revenue, new combined cost structure) Net present value of initiative
Detail on CTA	Breakdown of key costs, including estimating assumptions, timing, and amounts
​Detail on Recurring Operations	​Schedule of revenue accretion realization (note: will not likely commence and be ongoing at an even rate, as with cost synergies, so allow for ramp-up) New recurring costs corresponding to the revenue accretion realization timeline​
Roadmap	Joint product roadmap & assumptions
TAM & Share, by Product	Calculations of addressable market and presumption of share capture by product, with growth or decline where applicable
Pricing	Pricing assumptions with elasticity analysis
Sensitivity Analysis (Mandatory)	A sensitivity analysis presenting conservative, moderate, and aggressive scenarios

​Note the key differences in the cost and revenue synergy business cases.  Cost synergies, and accretive revenue synergies, typically have a defined start date, after which benefits are recurring. Extra-accretive revenue synergies tend to require a ramp-up period, reflecting the gradual release and penetration of joint market offers. 
While assumptions are required in all cases, extra-accretive revenue business cases rely on assumptions that are more subjective.  As such, it is critical to include a robust analysis of TAM, market share, and pricing to document and substantiate your conclusions.  Sensitivity analysis is also more critical for these business cases due to the reliance on these assumptions.

Other Considerations
It’s common for deal models to have both revenue and cost synergy projections.  In this case, you would simply combine the business case methods above to get total CTA, taking care not to double-count any costs.  If using both interim and end-state TOMs, remember to factor in timing.

Conclusion
Business cases are the most common method of analyzing costs to achieve modeled deal synergies.  Personnel costs can often be estimated without resorting to the preparation of full business cases; however, if business cases are being prepared while a simpler analysis is being used to calculate personnel reduction savings, take care not to double-count costs and benefits. 
​
Overall, remember that the purpose of including costs to achieve in the deal models is to accurately calculate the return from the transaction, and to validate the deal valuation.  This objective should guide you in determining which deal value drivers should have CTA business cases, with the goal being to substantiate at least 80% of the projected deal value.